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February 1, 2001

Bipartisan Medley

If both parties can agree to work in concert, last

In the past year, Congress, the IRS, and the Department of Labor took initiatives to expand the use of IRAs as retirement savings vehicles. The Congressional efforts are reflected in the Retirement Security and Savings Act of 2000, passed by the Senate Finance Committee, and the Comprehensive Retirement Security and Pension Reform Act of 2000, passed by the House of Representatives. While neither became law, it is likely that most of the IRA-related provisions in the bills will be re-introduced this year. The IRS and Department of Labor are also likely to continue to issue regulations to facilitate the use of IRAs.

Legislative Proposals

There are two types of IRAs under present law: traditional IRAs, to which both deductible and nondeductible contributions may be made, and Roth IRAs. The legislative initiatives primarily focus on increasing the contribution limits for both types of IRAs and facilitating rollovers between traditional IRAs and employer-sponsored retirement plans. When it comes to traditional IRAs, here's what lawmakers are considering:

Increase in Annual Contribution Limits The maximum annual dollar limit for IRA contributions would be increased from $2,000 to $3,000 in 2002, $4,000 in 2003, and $5,000 in 2004. The limit would then be indexed in $500 increments in 2004 and thereafter. Both bills contained this provision last year.

Increase in AGI Limits for Deductible IRA Contributions Adjusted gross income limits for deductible IRA contributions would be raised. Under present law, an individual may make tax-deductible contributions of up to $2,000 to an IRA if neither the individual nor the individual's spouse participates in an employer-sponsored retirement plan. If the individual does participate in an employer-sponsored plan, the $2,000 deduction limit is phased out for taxpayers with AGI over certain levels. If the individual is not a participant in an employer-sponsored plan but the individual's spouse is, the $2,000 deduction limit is phased out for taxpayers with AGI between $150,000 and $160,000.

In the Senate bill, the AGI limit levels for an active participant individual would be increased by $4,000 at each level and evened out between the levels for both single and joint filers. The present AGI phase-out range for an individual who is not an active participant, but whose spouse is, would remain the same.

Tax-free IRA Withdrawals for Charitable Purposes Certain qualified charitable distributions from IRAs would be excluded from the gross income of the individual if such distributions are made directly to a qualified charitable organization, if the distribution is made after age 70 1/2 and if it qualifies as a charitable contribution under the tax code. The amount otherwise allowable as a deduction for such contributions would be reduced by the amount of the qualified distributions from the IRAs for that year.

Deemed IRAs Under Employer Plans Employers would be able to allow employees to make IRA or Roth IRA contributions to a separate account within their retirement plans (such as 401(k), 403(b) and 457 plans). The separate account would be treated as an IRA or Roth IRA, and would not be subject to any applicable plan testing requirements.

Rollovers From IRAs to Retirement Plans A deductible IRA owner would be permitted to roll over, tax-free, from the IRA to a 401(k), 403(b) or 457 plan, a change from present law. No such rollover would be permitted from nondeductible IRAs. This proposal is especially important for those deductible IRA owners who reside in states that do not protect IRAs from the claims of creditors in bankruptcy.

IRS Doings

During 2000, the IRS issued numerous regulations and rulings concerning traditional and Roth IRAs. Two stand out. Rev. Rul. 2000-2 Overriding Rev. Rul. 89-89, Rev. Rul. 2000-2 provides that an IRA may now qualify as a qualified terminable interest property (QTIP) trust even if all the income of the IRA is not currently distributed to a surviving spouse. Under the Code, a decedent's taxable estate is determined by deducting from his or her gross estate the value of any interest in property passing to the surviving spouse. Such a marital deduction is not allowed, however, if the interest passing to the surviving spouse will terminate and be thereafter passed to someone other than the surviving spouse. A QTIP, however, qualifies for the marital deduction even if the interest therein only passes to the surviving spouse during his or her lifetime and thereafter, to other beneficiaries.

The essential requirement of a QTIP is that the surviving spouse must have a "qualifying income interest for life" in the property. Under the overruled Rev. Rul. 89-89, to satisfy this requirement the QTIP trust must require that both the income earned on the undistributed portion of the IRA and the income earned by the QTIP trust on the distributed portion be paid to the surviving spouse for life. Rev. Rul. 2000-2 eliminated this requirement. It provides instead that the surviving spouse be given the right to compel the QTIP trustee to withdraw all of the income earned by the IRA, without having to actually receive a distribution. The ruling allows income to accumulate tax-deferred in the IRA, allowing more property to pass to the QTIP's remainder beneficiaries.

Private Letter Ruling 199951053 This ruling allows IRA designated beneficiaries to take distributions over the life expectancy of the oldest beneficiary after the IRA owner's death, despite the fact that the IRA owner had been taking distributions over her single life expectancy recalculated annually during her lifetime.

The Code requires that an IRA satisfy the minimum required distribution (MRD) rules which provide, inter alia, that where a distribution has begun from an IRA after the owner has reached age 70 1/2, any remaining portion of the IRA must be distributed after the owner's death at least as rapidly as under the method of distribution used as of the date of death. If the life expectancy of the owner is being recalculated, the recalculated life expectancy is reduced to 0 at the end of the year following the year of the owner's death. Applying the MRD rules to this case, since the IRA owner elected to receive her MRD over her single recalculated life expectancy, her life expectancy would have to be reduced to 0 after her death, and her beneficiaries (her three sons) would have to receive their distributions from her IRA in a lump sum. The IRS ruled, however, that since the IRA owner timely designated the beneficiaries and could have used her and her oldest son's joint life expectancy to determine the amount of her MRD, her beneficiaries may receive their distributions after her death over the life expectancy of the oldest son without violating the "at least as rapidly" requirement of the MRD rules. The ruling provides a significant planning opportunity for those IRA beneficiaries who desire to stretch out tax payments on distributions from the IRAs whose owners have been taking distributions over their recalculated single life expectancies. Taxpayers should consult their attorney to ensure the validity of such an arrangement.

Labor Advice

An important guidance issued by the Department of Labor regarding IRAs in 2000 was its Advisory Opinion 2000-15A. In the opinion, the DOL clarified that Prohibited Transaction Exemption 84-24 applies to IRA transactions.

PTE 84-24 provides a conditional exemption from the prohibited transaction rules of ERISA and the corresponding penalty taxes imposed by the Code for transactions relating to the purchase with "plan" assets of certain insurance products or mutual funds and the receipt of sales commissions in connection with such purchase by insurance agents or brokers, pension consultants, and mutual fund principal underwriters. Since the PTE does not define the term "plan," TIAA-CREF sought clarification from Labor as to whether the exemptive relief provided by PTE 84-24 also extended to IRAs. Labor ruled that PTE 84-24 does indeed apply to IRAs. It also cautioned, however, that PTE 84-24 would not exempt any prohibited transaction arising from any fees received by the service providers, which are separate and apart from the sales commissions, for rendering fiduciary investment advisory services to the IRA owners.

The opinion clarified that insurance agents or brokers, pension consultants, and mutual fund underwriters selling IRAs may avail themselves of the exemptive relief provided by PTE 84-24 for their receipt sales commissions for effecting the purchase of an annuity or mutual fund shares by their IRA owner clients if they meet the terms and conditions of PTE 84-24.

In conclusion, it is evident that the recent legislative and regulatory initiatives are designed to encourage individuals to save more for their retirement through IRAs. Stay tuned for further developments.